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ACCOUNTING BLOG

15 YEARS AGO, SHREDDED PAPERS … AND A VENERABLE FIRM FALLS

Fifteen years ago this month, the big Andersen
aftershock of the corporate earthquake known as the Enron scandal took place.

Enron Corp. crashed and burned in late 2001.
Venerable Arthur Andersen LLP went down the following summer, after a winter of
agony.

Andersen, auditor of the high-flying Houston
energy and trading company that was the seventh-largest company in America, got
so caught up in the dangerous slipstream of Enron’s house-of-cards dealings
that it became a victim. A victim of its own missteps and of circumstances, one
Andersen veteran told me—and of historical confluences.

Enron was the leading audit and consulting
client for the 89-year-old Chicago accounting house. It paid out more than a
million dollars per week, total, in fees to Andersen, former Securities and
Exchange Commission Chairman Arthur Levitt Jr. told PBS’s “Frontline” in 2002.

Fatal Feature in the Case.

The standout headlines in January 2002 went to
the unusual, ultimately fatal feature of the auditing episode: Andersen had
destroyed papers used in the audit of Enron financial reporting that became
notorious for keeping huge, crippling liabilities off the Houston company’s
balance sheets.

Here is the headline and lead sentence of a BNA
story [before the Bloomberg appellation] of Jan. 11, 2001, as reported by my
former colleague Rachel McTague:

“Big Five accounting
firm Andersen LLP said Jan. 10 that its
employees disposed of or deleted a significant number of documents related to
its audit of Enron Corp., which suddenly collapsed and in December filed for
the largest ever U.S. bankruptcy.”

To cut to the chase, efforts to keep Andersen
out of the sights of a federal grand jury failed. The firm was indicted in
March 2002 on one count of obstruction of justice. Andersen was convicted after
a trial by jury in June 2002. It appealed.

By late
August of that year, Andersen had effectively ceased as a going concern. It was
barred from public company auditing. Andersen’s roll of roughly 28,000 US-based
partners and employees was reduced to about 3,000 at the end of summer of 2002,
according to The New York Times.

Supreme Court Reverses Conviction.

In May
2005, the U.S. Supreme Court reversed the conviction of Andersen LLP. Its
ruling was unanimous.

“The
jury instructions failed to convey properly the elements of a ‘corrup[t]
persuas[ion]’ conviction under [18 U.S.C.] §1512(b),” according to the high
court. “The jury instructions failed to convey the requisite consciousness of
wrongdoing. Indeed, it is striking how little culpability the instructions
required.”

However,
it was too late for Andersen, as former U.S. Comptroller General Charles
Bowsher—a two-decade-plus partner at the accounting firm—told me Jan. 17.
The respected Chicago firm was history.

Bowsher,
who also chaired the old Public Oversight Board, a self-regulatory board for
accounting that preceded the Congressionally-mandated Public Company Accounting
Oversight Board, faulted the leadership of Andersen for what he views as a
failure to head off an indictment. And he criticized the Department of Justice
for bringing the criminal action against the firm.

“It was
just such a tragedy,” Bowsher said of Andersen’s demise. “It was such a great
firm.”

A Negative History.

Andersen
unfortunately had also accumulated a history -- one that any firm or company
wouldn’t welcome.

In 2000
and 2001, Andersen had gotten into serious hot water with the SEC over its
audit of Waste Management Inc. A commission enforcement action led to Andersen
and three of its partners, in June 2001, settling a fraud complaint brought by
the agency—and to a record $1.43 billion restatement by WMI.

Also in
2001, Anderson faced unwanted scrutiny for its audit work for Sunbeam
Corporation.

The SEC
brought a securities fraud case against Sunbeam. It named the Andersen audit
engagement partner in that case along with Sunbeam executives. In addition, Andersen
settled a shareholder suit against it, stemming from allegations in the Sunbeam
audit episode, for $110 million, a notable settlement amount for a shareholder
action against a CPA firm.

WorldCom’s Auditor, Too.

Finally,
as part of its unfortunate history, Andersen was the auditor of WorldCom, the
focus of another huge financial scandal in 2002.

The
Mississippi telecom failed in a spectacular meltdown spurred by its having to
make a $3.8 billion-plus restatement—and its audit committee finding that a
fraud had resulted in overstating revenues by a like amount, as Brickey
recounted.

The
WorldCom debacle proved to be the spark that restarted Congressional movement
toward concrete corporate and accounting reform in the summer of 2002, after
legislative efforts seemed to be flagging in the spring. The scandal propelled
lawmakers and Pres. George W. Bush to complete the process leading to the
landmark Sarbanes-Oxley act and the creation of the PCAOB as well as
independent funding for the Financial Accounting Standards Board. [See my blog
report of January 2016, on the passing of former Rep. Michael Oxley, at https://www.bna.com/reluctant-reformer-passing-b57982066528/.]

Young and Ciesielski Look Back—and
Forward.

I asked a few
people who are versed in accounting and its regulation or related litigation to
look back on the Enron scandal, the demise of Andersen and what came after.

"It is hard to describe to nonparticipants the
hysteria of the moment,” attorney Michael Young, partner at Willkie, Farr &
Gallagher LLP, New York, wrote to me in a Jan. 12 email message. “Fifteen years
after Enron, this may be a good time to revisit the regulatory reaction and,
with hindsight, to think about whether it could be refined a bit."

Young, a leading legal defender in
accounting-related cases and author of “Financial Fraud Prevention and
Detection” (Wiley & Sons, 2013), explained that “we now have 15 years of experience under our
belt and it may be useful to revisit some of the reforms and see if they should
be fine-tuned.”

In
Baltimore, Jack Ciesielski, a CPA, security analyst, and publisher of Analyst’s
Accounting Observer, told me Jan. 12: “Investors are in a better place. This led to reform
of auditing through enactment of [the] Sarbanes-Oxley Act.

And for all the tears shed about the costs of
Sarbanes-Oxley, we have avoided, to a great degree, the costs associated with
corporate flame-outs.

“The unintended consequence has been the emigration
of companies from the public markets to private equity,” Ciesielski added. “We
haven't yet seen how that's going to play out.”

Levitt,
Turner: Risks of Consulting vs. the Traditional Audit.

Levitt and Lynn Turner, about a year after
their stints as SEC chief and the commission’s chief accountant, respectively,
saw in 2002 the dangers of an audit firm shifting too much into lucrative
consulting lines and away from the traditional audit.

“In
my judgment, that accounting firm was compromised,” Levitt said of Andersen in
the “Frontline” interview. “Putting aside any fraudulent activity that may have
been part of this, they were clearly compromised by the nexus of consulting
with auditing.”

Turner,
a former partner at the pre-PWC Coopers & Lybrand, told the same PBS
“Frontline” series in April 2002 about the trend he saw at the giant accounting
houses. They were tapping their audit clients for well-paying consulting
contracts and the non-audit business was becoming much more important. They
sought more revenue and profitability, he said.

“And
as we've seen, they all grew their consulting practice phenomenally during the
1990s to accomplish that, and that has become what their business is,” Turner
said. “They used to be principally auditing firms. Today they are a business
firm, and the CEOs and culture at the top of these firms is, ‘What can we do to
make our business more profitable?’ "

The
Sarbanes-Oxley law drew boundaries on what non-audit work an independent
auditor could do for an audit client.

SEC Accountants’ Words of Warning.

In
2010 and 2012, the top accountants at the SEC—respectively, James Kroeker and
Paul Beswick—spotlit audit firms’ consulting practices that were being
rebuilt. The reconstruction made for a mix of business that apparently
warranted regulatory attention (again).

Beswick
voiced concerns about the risks to auditor independence that are presented when
leading audit firms boost their non-audit consulting business.

In December, Wesley Bricker, the current SEC
chief accountant, issued a similar reminder at the big annual American
Institute of CPAs conference in Washington. “[C]onsideration
should be given to whether any relationship or service to be provided by an
auditor” could impair independence, he cautioned Dec. 5.

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